Accrual accounting
Encyclopedia of Business Terms and Methods, ISBN 978-1-929500-10-9. Copyright © 2012 by Marty J.Schmidt. Revised 11 January 2012.
The Meaning of Account Accrual Accounting
Accrual accounting is the practice of accounting for revenues in the period in which they are earned and for expenses in the period in which they are incurred. Under accrual accounting, for instance, a sale is recorded as revenue even if the customer has not yet paid (the revenue is part of accounts receivable).
Accrual accounting is standard, normal accounting practice for the overwhelming majority of businesses, large and small, across industries, worldwide. Accrual accounting contrasts with cash accounting (or cash basis accounting), which accounts only for cash receipts and payments, and which does not support the financial reporting requirements of public companies.
In business, days, weeks, or even months may elapse between the time a sale is closed (contracted) and the time cash actually transfers from buyer to seller. Customers may buy on credit, or may pay their account balance with a seller only once a month, or they may receive an invoice from the seller that allows 30 days or more to make payment (e.g., "...net due 30 days from receipt of invoice."). One tenet of accrual accounting is the belief that a company's financial situation changes more so when the sale is earned or the cost obligation incurred, than when cash payment is actually made.
The use of accrual accounting allows allows companies more easily to apply the matching concept--also standard practice in accounting—that is reporting revenues earned in the same accounting period with the costs and expenses that produced those revenues.
Cash basis accounting can be understood and implemented by people with little or no exposure to the basic principles and methods in bookkeeping or accounting. Understanding and using accrual accounting, however, requires at least a basic understanding of such concepts as the account, the chart of accounts, and double-entry-bookkeeping. This understanding is crucial, moreover, for understanding and using the primary financial reporting statements produced with an accrual accounting system, the income statement, the balance sheet, the statement of changes in financial position (SCFP), and the statement of retained earnings.
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